Shocked that companies and mutual funds would invest OPM (Other People's Money) in high-risk investments, the Shocked Investor was originally on a mission to find out if our money ended up in these dubious instruments. This blog now also discusses other financial topics, such as straddles, options, gold, natural gas, agri/food stocks, and the collapse of the US Dollar.

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Monday, June 28, 2010

That recessions are quite common while depressions are rare is well known. Paul Krugman’s latest column in The New York Times says that as far as he can tell, there were only two eras in economic history that were widely described as “depressions”:

the well known years of mass unemployment that followed the financial crisis of 1929-31.

the lesser known years of deflation and instability that followed the Panic of 1873

Neither of them were periods of uninterrupted declines, quite on the contrary, both had several growth periods. Sounds familiar?

However, Krugan argues that these episodes of growth were not (never) enough to "undo the damage from the initial slump".

"We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.

And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G20meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending".

The Fed and the ECB and pretty much every country in the world slashed interest rates to almost nil rates to support credit markets. Krugma explains that "unlike governments of the past, which tried to balance budgets in the face of a plunging economy, today’s governments allowed deficits to rise. And better policies helped the world avoid complete collapse: the recession brought on by the financial crisis arguably ended last summer".

He states that future historians will write that this wasn’t the end of the third depression, similarly to the fact that pickup in business that started in 1933 wasn’t the end of the Great Depression.

"After all, unemployment — especially long-term unemployment — remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style deflationary traps.In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy".

Similary to the past as well, in Europe they talk about raising taxes and cutting spending as if they would expand the economy by improving business confidence. "As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing. The Obama administration understands the dangers of premature fiscal austerity — but because Republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts at the state and local levels".

"And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again".